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October 9, 2013

Loss-Leader Pricing Often a Losing Bet

PriceMetrix study suggests that advisors using loss-leader approach need to be sure they’re making up losses with premium pricing elsewhere

Rampant discounting by advisors in pricing their services — while possibly the result of a lack of confidence in the value they offer clients — is often dressed up in the language of business grand strategy. Discounted commissions are portrayed as merely “loss leaders” that make possible the higher fee income the advisor is seeking, or vice versa.

A recent study by PriceMetrix takes a closer look at how loss-leader pricing stacks up in the advisory industry and suggests that advisors — through inconsistent pricing — might not be making up for their losses.

The Toronto-based practice management software and data services company undertook the study after hearing many advisors describe their discounting as part of a formal strategy.

“We hear advisors say all the time that they recoup revenue given up on their fee-based business through their transactional business, as well as the reverse,” Doug Trott, president and CEO of PriceMetrix, said in a news release. “This could be an effective strategy, if that’s what advisors really did.”

To find out what advisors were doing, PriceMetrix first took a broad look at pricing of household asset management and found it to be remarkably uniform.

Narrowing its field of study to households with between $500,000 and $1 million in assets and hybrid fee and commission pricing, PriceMetrix found that 25% paid discounted commissions but nondiscounted fees; 25% paid premium pricing on both; 25% received discounted pricing on both; and 25% paid discounted fees but nondiscounted commissions.

PriceMetrix then altered the view, moving from household assets to the advisor level, and found that advisors were likelier to maintain consistent pricing across fees and commissions than they were to use loss-leader strategies (despite much anecdotal information about the prevalence of this approach).

“Examining aggregate fee and non-fee pricing for hybrid households across thousands of advisors’ books reveals that 21% of advisors trade off fee revenue for non-fee revenue, and another 21% trade off non-fee revenue for fee revenue. The more frequent outcomes are for advisors to price both types of business consistently — at a premium (29%) or at a discount (29%),” the study finds.

Finally, within these various hybrid revenue models, PriceMetrix looked at how consistent advisors were with individual households and found that the percentage of households in the same quadrant as the advisor never exceeded 50%.

“Our analysis indicates that advisors are just as likely to be consistent as they are to be inconsistent in how they price from one household to another,” the report finds. That inconsistency makes the efficacy of the model employed by the advisor uncertain.

The report concludes:

“Effective pricing for individual advisors can mean different things. It may mean disciplined pricing consistent across product lines, or it may mean making a conscious choice to forgo revenue in one place and reliably recoup it elsewhere. Advisors who do pursue a loss leader pricing strategy need to be certain that pricing on the other half of their business truly is performed at a premium.”

The firm suspects this is not happening and recommends advisors examine their books of business very carefully in order to capture lost revenue opportunities.